Monday, October 26, 2009

The role of resources: NZ vs Australia

I found the speech quite interesting, especially his analysis that some of the problems that are perceived to be problems actually don't seem to be. He is concerned about debt, as anyone should be, although my latest analysis on the debt problem lead me to conclude that debt, in and of itself, may not be a fundamental problem but that area needs a lot more work yet. The most interesting piece in Dr Brash's speech was the identification of a phenomenon in the Australian economy that was already perplexing me about New Zealand.

The popular opinion on Australia is that it is the lucky country due to its mineral wealth. Likewise the accepted mantra in New Zealand is that agriculture (and dairying) is the engine room of our economy. One might say that Australia is a giant mine and that New Zealand is a giant farm. The problem is that neither of these assertions appears to be true.

Dr Brash makes the assertion that the entire Australian mining industry only contibutes about 5% to the Aussie GDP. Likewise, from Statistics NZ, agriculture is the same about 5% of Kiwi GDP. So, which is it? Logically natural resources should be a significant driver on financial wealth but the statistics suggest that neither of New Zealand's or Australia's perceived main industries is actually our main industries.

The most likely reason I can think of that each of our main industries may hit above their weight is leverage. By leverage I mean that each of our main industries stimulates other commercial activity in significant volumes. Such leverage can either be what I call output leverage or input leverage.

There are a number of ways in which GDP can be calculated. It appears that Statistics New Zealand uses the value add method where the GDP contribution of a category is the direct cash sales less direct cash costs. In theory the resulting number is the value that that activity adds to the cash economy.

My definition of output leverage is that the output from an industry stimulates other commercial activity. For example, tourism not only generates its own direct sales but also stimulates retail and service trade. Here it seems agriculture generates signicant economic activity in New Zealand. Manufacturing and retail trade seem to be particularly driven by value adding on agriculture production. In New Zealand perhaps a third of retail trade and approaching half of manufacturing is oriented around food production and agricultural products.

My definition of input leverage is where the commercial activity around providing input to an industry stimulates business activity. It is very hard, from the available statistics to work out how much of New Zealand's economy is driven by providing goods and services to agriculture. It is reasonable to assume that infrastructure type services such as electricity, communications and construction support agriculture roughly in proportion to its economic activity. Therefore, agriculture may, prima facie, contribute as much as 30-40% to the New Zealand economy.

Federated Farmers suggest that the actual contribution of agriculture to GDP is 17% (http://www.farmday.org.nz/page12.html), but without sources. This is a credible number as my analysis includes activity that would occur anyway (people need to eat). Coming up with a real number is very hard as there is no way to properly consider dynamic effects. In theory New Zealand could still add value in the economy if it imported the agriculture produce. Japan, for example, imports raw material and exports high technology products. But one has to consider the degree to which having the resource stimulated the value adding industries that we now have. It seems intuitively obvious that if someone has an excellent agricultural resource that they would become very good, and continue to be good, at manufacturing excellent valuable food products.

One must also consider other welfare effects that come from having access to relatively low cost, high quality food with little external dependancy. Having a major industry based on primary agricultural produce may limit the opportunities for financial wealth but, with a partisan strategic hat on, having a surplus of good food is a significant benefit to any country. It seems to me that most countries protect their agriculture because the strategic implications of being able to be cut off from the food supply are huge.

But is agriculture the engine room of New Zealand's economy? What else drives the economy? Well agriculture seems to be the largest grouping of economic activity (and dairying and meat in particular). We seem to do a lot of other things but nothing particularly large. We make machinery, we make chemicals and plastics, we do a lot with wood and paper, we certainly build a few houses. We seem to do a lot of things. On the whole we seem to be a nation of small business people. Even farming is predominantly built on the small business model, although there has been signficant rationalisation in recent years.

That we would be a nation of small business people makes sense to me. New Zealand is a country of relatively well educated people far from international markets with substantially pastoral resources. It makes sense that much of our economic activity (apart from agriculture) would be based on being flexible opportunists.

I'm not sure whether agriculture is the engine room of our economy but one thing does seem clear to me. It is the only industry in which New Zealand has a clear strategic advantage of any scale.

As this post is now seems large enough as it is I will consider Australia in a new post.

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